Is Kroger's Post-Earnings Pullback a Buying Opportunity?

Shares of Kroger (NYSE: KR) plunged 10% on Sept. 13, after the supermarket chain posted mixed fiscal second-quarter 2018 numbers. The company's revenue rose 1% against the prior-year quarter to $27.9 billion, but this top line missed analyst expectations by $100 million and amounted to its slowest growth in nearly three years.

After excluding fuel sales, the divestiture of its convenience store business, and its acquisition of Home Chef, Kroger's revenue rose 1.8% -- but that was still a significant slowdown from its 2.8% growth on the same basis in the first quarter.

On the bright side, Kroger's identical-store sales (excluding fuel sales) rose 1.6%, compared to 1.4% growth in the first quarter, marking its fifth straight quarter of positive identical-store sales growth. Management also reaffirmed its guidance for 2% to 2.5% identical-store sales growth for the full year.

But mind the margins...

However, Kroger's gross margin -- excluding fuel and a $12 million LIFO (last in, first out) charge -- fell 36 basis points year over year to 21.3%, due to more aggressive discounts, higher transportation costs, and the growth of its specialty pharmacy unit. On a rolling-four-quarter basis, Kroger's adjusted FIFO (first in, first out) operating margin fell 26 basis points.

As a result, the company's non-GAAP earnings (which exclude Kroger's investment in British online grocer Ocado and other one-time benefits) slid 5% to $336 million, or $0.41 per share -- but still beat expectations by $0.04. On a GAAP basis, its net income rose 44% to $508 million, or $0.62 per share.

Kroger still reaffirmed its full-year guidance for non-GAAP earnings of $2.00 to $2.15 per share -- a range which equals a 2% decline to 5% growth. Analysts currently expect Kroger's revenue to stay flat this year, and for its adjusted earnings to rise 4%.

Are Kroger's growth plans still intact?

Kroger is struggling to stay relevant in a market filled with superstores like Walmart (NYSE: WMT), warehouse retailers like Costco (NASDAQ: COST), and e-commerce behemoths like (NASDAQ: AMZN), which swallowed Whole Foods last year. All that competition is lowering consumer price expectations, and the battles are now shifting toward aggressive delivery and pickup options.

Kroger is the biggest supermarket chain in the United States, but it still generates much less annual revenue than Walmart, Costco, or Amazon -- each of which is generating stronger sales growth. Analysts expect Walmart's revenue to rise 3% this year, Costco's revenue to climb 9%, and Amazon's revenue (boosted by its cloud business and Whole Foods) to jump 32%.

Last year, Kroger launched "Restock Kroger," a three-year turnaround plan which uses big data and analytics to optimize its prices, product selections, and personalized communications with customers. It's also expanding its private-label brands, organic products, and meal kits (boosted by its takeover of Home Chef) to counter Amazon's buyout of Whole Foods. It's also launched some of its private-label brands in China via Alibaba's Tmall.

On the digital front, Kroger introduced ClickList, a paid service which lets shoppers buy products and pick them up at its stores, and Ship, a new direct-to-consumer shipping platform. It's also partnered with couriers like Instacart, Shipt, and Uber for home deliveries, and it plans to integrate some of Ocado's online grocery technologies into its U.S. stores. It's even testing out a driverless delivery service with autonomous delivery service startup Nuro.

Kroger's digital sales rose over 50% over the last three months versus the comparable prior-year quarter, but that marks a deceleration from its 66% growth in the first quarter. That's disappointing considering that Kroger's "seamless" coverage (between its brick-and-mortar and digital services) rose from 75% in the first quarter to 80% in the second quarter.

This indicates that all of Kroger's aggressive ecosystem investments -- which are weighing down its margins -- might still fail to keep Walmart, Costco, and Amazon at bay. Kroger is trying to cut costs by banning Visa credit card payments at its stores (due to Visa's higher swipe fees), but that move could alienate its existing customers.

Stick with Kroger's competitors instead

Kroger's stock looks cheap at 13 times forward earnings, and it pays a forward dividend yield of 1.7%. But I believe that Walmart, Costco, and Amazon are all more compelling investments than Kroger -- which is desperately trying to catch up from a losing position.

Kroger won't be rendered obsolete anytime soon, but it will likely keep spending a lot of money to squeeze out unimpressive sales growth. Therefore, I'd stay away from Kroger until its big investments start generating some visible top-line gains.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Leo Sun owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool owns shares of Visa. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.